5 Major 401(k) Rollover Rules You Need to Know

Learn these rollover and withdrawal rules to avoid penalties.

401(k) rollover rules

If you are moving jobs or retiring, you might qualify for a 401(k) rollover. A rollover can help you consolidate multiple retirement accounts or reallocate investments into more profitable accounts. You can roll over a 401(k) from a previous employer’s plan to an individual IRA or a new employer’s plan. Whether you plan to roll over assets from one retirement account into another, or you are considering withdrawing cash from your 401(k), be mindful of these following rules to help you avoid paying high penalty fees and taxes.

Related: 9 Signs You’re Not Saving Enough for Retirement

About 401(k) Rollovers

Qualifying Events for 401(k) Rollovers

A 401(k) rollover allows you to reinvest your retirement savings. Rolling funds over into an IRA can allow you to keep savings tax-deferred while opening up new investment options. To qualify for a rollover, you must have a qualifying event. Common qualifying events include:

  • Getting a new job
  • Becoming permanently disabled
  • Retiring

Choosing to roll over your 401(k) can help you reassess how you are investing your money. Consider your long-term financial goals as you research your rollover options.

Why Roll Over Your 401(k)?

You might choose to roll over your 401(k) plan in order to reallocate assets or to benefit from a new employer’s plan. Consolidating assets with a new employer can make managing your money easier. You can even explore your new employer’s investment options to find opportunities for diversifying your portfolio.

Even if you leave your current employer, you might not be required to roll over your 401(k). Keeping your 401(k) with a previous employer can be beneficial if your new employer does not offer the same benefits or competitive investment options.

Withdrawing From Your 401(k)

Your 401(k) plan might allow in-service withdrawals if you face financial hardships. 401(k) withdrawals are generally required to be used to pay for certain expenses, such as medical costs, tuition or to purchase primary residences. Other 401(k) plans might allow you to make in-service withdrawals if you are a certain age and plan to roll your assets into an IRA or other qualified plans. If you do not meet certain requirements before withdrawing from your 401(k), you might incur a 10 percent early withdrawal penalty.

Cecelia Brown, a certified financial planner with Beach Brown LLC, told GOBankingRates: “Depending on your plan, if you retire after the age of 55 but before the age of 59 1/2, you may be able to avoid paying the 10 percent early withdrawal penalty. This provision has to be specifically written into your plan, so it doesn’t apply to everyone.”

Why You Shouldn’t Cash Out Your 401(k)

Some investors choose to cash out on retirement plans rather than reinvest assets. While you might have the opportunity to cash out on your 401(k), Brown said it might not be your best option:

“You have to pay taxes when you cash out a retirement plan. Not only ordinary income taxes, but also potentially a 10 percent IRS penalty for cashing out prior to age 59 1/2. Also, the longer you have money in a retirement plan, the longer it has to grow without paying taxes on earnings. Those taxes, as well as compound interest, can add up to a lot of money over time.”

5 Biggest 401(k) Rollover Rules

1. 60-day 401(k) Distribution Rule

If you plan to withdraw 401(k) funds with the intent of reinvesting, beware the 60-day 401(k) distribution rule. If you receive funds from your 401(k), you have 60 days to move your assets into another qualified plan. If you fail to roll over your funds within 60 days, your withdrawn distribution will be treated as income and be subject to ordinary income taxation.

Additionally, there are tax withholdings on 401(k) cash distributions. If you recently moved jobs, you can request your former employer to directly transfer the funds in your 401(k) to another 401(k) or IRA. Having your former employer transfer funds can help you avoid the 60-day 401(k) distribution rule.

2. One-Year IRA Rollover Waiting Rule

In 2014, the United States Tax Court ruled that you can only make one tax-free IRA rollover each year. This ruling applies even if you have more than one IRA. Your one-year waiting period begins on the day your funds are rolled over into another retirement account.

3. Same Property Rule

If you are considering using a 401(k) withdrawal to buy stock or another type of asset, the same property rule will apply. This IRA regulation stipulates that unless you are 59 1/2, the funds taken from your retirement account must be rolled over into the same type of account. Your assets will otherwise be taxed as income.

4. Required Minimum Distributions

Withdrawals from an IRA or other retirement plan is mandatory after you turn 70 1/2. By April 1 of the year following the calendar year you reached 70 1/2, you must start making annual withdrawals from your retirement accounts. The amount you must withdraw is known as your required minimum distribution (RMD).

Withdrawals you make are considered taxable income unless they were taxed before or withdrawals were received tax free. If you have both a Roth IRA and a traditional IRA, withdrawals from your Roth IRA will not satisfy the annual RMD for your traditional IRA. Withdrawals are not mandatory for Roth IRAs until your death.

Related: CNBC’s Sharon Epperson on Why You Need a Roth IRA in 2015

5. Managing Stock Distribution

When you receive company stock from an IRA, your distribution might be taxed. If you transfer shares to an IRA, however, you avoid immediate taxation of your assets. If you sell shares to transfer cash into another IRA, your withdrawal will be taxed at the income tax rate for the year of your distribution.

Whether you are ready to retire or simply want to switch jobs, properly managing your 401(k) can help you avoid paying taxes and other fees. Consider your options as you review your assets and speak with a qualified financial planner if you are unsure how to approach 401(k) withdrawals or rollovers.

Keep Reading: What to Do if Your Job Offers an Awful Retirement Plan